Real Exchange Rate Misalignment: An Application of Behavioral Equilibrium Exchange Rate (BEER) to Nigeria

Abstract:     
This paper seeks to estimate the long run behavioral equilibrium real exchange rate in Nigeria. The econometric analysis starts by analyzing the stochastic properties of the data and subsequently estimates a vector error correction model. Regression results show that most of the long-run behavior of the real exchange rate could be explained by terms of trade, index of crude oil volatility, index of monetary policy performance and government fiscal stance. The results further suggest that deviations from the equilibrium path are eliminated within one to two years. Meanwhile, the coefficients of the fundamentals in the model are used to identify episodes of overvaluation and undervaluation of the real exchange rate. Large inflow of oil revenues into the country and stable macroeconomic performance, for instance, were discovered to account for undervaluation of the real exchange rate between 2003Q3 and 2004Q4 in Nigeria and overvaluation in 2005Q1 and 2006Q4. The paper, therefore, recommends the pursuance of a sound monetary policy and reduction in fiscal dominance as instruments for achieving real exchange rate cum macroeconomic stability in Nigeria.

Number of Pages in PDF File: 29

Keywords: real exchange rate equilibrium, stationarity, cointegration, Hodrick-Prescott decomposition

JEL Classification: C22, F31

working papers series